Harvard's experience shows what Obamacare could bring

Like other big employers, in the mid-1990s Harvard University was struggling with the ballooning cost of providing health insurance.

It chose what was a novel solution for the time. It dropped its standard deal, a subsidy that rose in line with the price of the insurance policy, and switched some 10,000 workers to a fixed subsidy that encouraged them to shop around.

For Harvard's accountants, the change worked wonders. A study a couple of years later by David Cutler, a Harvard economist, and Sarah Reber, a Harvard graduate, concluded that competition among insurers cut the university's health bill by 5 percent to 8 percent.

But not everybody was pleased. Families of workers who chose the preferred provider organization offered by Blue Cross/Blue Shield — the most comprehensive plan, with lots of doctors and hospitals on its network — faced a $500-a-year jump in their out-of-pocket spending on health care.

Younger and healthier workers canceled their PPO plans, enrolling in cheaper HMO options or dropping Harvard insurance altogether. Left with a sicker patient base, the PPO raised its premiums further, which prompted the next layer of relatively healthy customers to leave.

And so on. In 1997, Blue Cross/Blue Shield withdrew its PPO from the market, making it a victim of what economists call the death spiral of adverse selection.

Soon, the nation is set to experience a similar shock on a very large scale. Come October, millions of uninsured people will be able to choose one of several health plans, offered at four tiers of service and cost through health exchanges coming onstream in every state.

Cheap “bronze” plans will shoulder some 60 percent of patients' medical expenses. Pricey “platinum” plans will cover at least 90 percent. But insurers will not be allowed to exclude people with pre-existing conditions, or charge more for the sick, or put a lifetime cap on medical costs. Their policies will have to cover a minimum standard of care. And the government will subsidize those who cannot afford to buy the policies.

President Barack Obama and his advisers hope the overhaul will do two things. The first is extend coverage to tens of millions of Americans who today lack health insurance. The second is hold the line on rising health care costs.

“Over time, success will depend on what happens to the cost curve,” Cutler said. “If we don't bend the cost curve, everything will fail. The government won't be able to afford it. Nobody will be able to afford it.”

In theory, the overhaul could meet both goals. Millions of Americans armed with a subsidy and shopping among plans would bring consumer choice to bear, finally, on the health care industry. Insurers would compete to create policies that offered the most value for money, pressuring hospitals and doctors on behalf of all of us.

Yet despite the care the administration took in establishing incentives and safeguards, even some of Obamacare's most committed backers are wondering whether the experiment will work as advertised — or, like Harvard's PPO, will go off the rails along the way.

Adverse selection is perhaps the direst threat. For Obamacare to work, millions of healthy, young, uninsured Americans must join a health plan to counterbalance the sicker millions who are most likely to buy insurance. Otherwise, health plans on the exchanges will have to raise premiums to shoulder the higher costs.

Selection also will take other forms. Healthier Americans probably will flock to cheaper bronze plans, and insurers will vie to enroll the healthy. In some states, big insurers have chosen not to participate in exchanges to avoid their strictures. On the outside, they still could sell cheap plans to skim off the healthy and avoid a rule that insurers on the exchanges also must offer more generous silver and gold plans.

Adverse selection is not the only risk.

A few studies have found that more competition among health insurers leads to lower hospital fees on average and that premiums rise when insurer competition diminishes. But researchers also have found that top hospitals — which any decent plan must have on its network — increase their fees when more health plans compete for their business.

Some economists have voiced fears that insurers with small market shares will not have the clout to bargain effectively with enormous hospital systems.

This month, Washington state announced that it had rejected the applications of five health plans on the grounds that they did not have enough hospital capacity in their networks. John Holahan of the Urban Institute suggests that more states should worry about that possibility.

“We were told that insurers would develop narrow networks excluding high-cost providers and squeeze providers to give lower rates,” Holahan said. “But smaller insurers will probably not get a good network at good prices.”

Jonathan Gruber from the Massachusetts Institute of Technology, who advised the administration on the design of Obamacare, argues the health overhaul strikes the right balance between competition and regulation.

That might not be enough, though. Consider Harvard's experience. It eventually fixed its death spiral by requiring that every insurer offer an option with broad access to health providers alongside its typical HMO. It added risk adjustment. This prevented further health plan failures — but it did not shield Harvard from inexorably rising health costs.